Ukraine - Country economic memorandum (Vol. 2 of 2) : Annexes

Report No. 10029-UA Ukraine Country Economic Memorandum (In Two Volumes) Volume II June 2, 1993 Country Operations Division 2 Country Department IV Europe and Central Asia Region FOR OFFICIAL USE ONLY Docurnen t of the' World Bank This document has a restricted distribution and may be used by recipients oDnly in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.Report No. 1 543-EAP  FOR OFFICIAL USE ONLY UKRAINE COUNTRY ECONOMIC MEMORANDUM VOLUME 1 CONENTS ANNEXES Annex A: Privatization ................................. I Annex B: Private Sector Development . .................................. 7 Annex C: Financal Seor Development ................................. 21 A.nnex D: Industry ................................. 50 Annex E: Agriculture . ................................. 72 Annex F: Energy Sector ......... ................................. 113 Annex G: TransportSector .............. ................... 122 Annex H: Environmental Sector .................................. 147 STATISTICAL APPENDIX This document has a restricted distribution and may be used by recipients only in the performanco of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  ANNEX A PRIVATIZATION 1. This annex provides an overview of the current status of privatization in Ukraine. It describes recent changes in the legal and institutional framework, and provides recommendations for reform on selected issues affecting Ukraine's privatization program, such as "spontaneous privatization," small-scale privatization, buyouts, buyers associations, vouchers, and technical assistance. 2. Privatization in Ukraine already has a history, starting with laws issued by the former Soviet Union; in particular, the Law on Leasing of Enterprises (mainly to workers' collectives). The Law was not very precise and led to a large amount of "spontaneous rrivatization". This process of spontaneous privatization was formally stopped in late 1991 by Decree 506 of the Supreme Rada "On the Protection of the Sovereign Rights of Property of the Ukrainian SSR". The Legal Framework 3. Soon after independence, the Ukrainians started creating the legislative base for a market economy. The Law on Ownership is the fundamental law which provides the starting point for privatization in Ukraine. It defines ownership rights for enterprises at the municipal, oblast and republican level. The Law on Privatization of State-Owned Companies contains a detailed description of privatization procedures and timetables. The Law on Small-Scale Privatization defines the types of enterprises that are subject to small-scale privatization, eligible sellers and buyers, the methods of privatization, and the procedures to be followed in preparation and execution of the privatization process. The Law on Privatization Certificates describes in general the types of special privatization securities and their use in the privatization of state property. 4. Other new laws, which have an important bearing on the privatization process, are the: - Law on Enterprises; - Company Law; - Law on Entrepreneurship; - Antimonopoly Law; - Law on Securities and Stock Exchange; - Law on Banking and Banking Activities; - Law on Foreign Investment; - Law on Protection of Foreign Investors. 5. The Law on Privatization requires the preparation of a State Privatization Program. This program is intended to be the Government's detailed implementation plan for the next two years. 6. The draft Program at present under discussion has the following aims, i.e., to: - establish a heterogeneous, socially-oriented market economy; - restructure the economy; - stabilize the economy; - increase the level of competition and break up monopolies;  -2- create conditions for starting and implementing the privatization process; attract foreign investment. 7. The draft Law presented to Parliament by the Council of Ministers in December 1991 gave responsibility for preparation of the program to the Ministry of Destatization and Demonopolization. The first draft version of this program was prepared by the Miistry in January-February 1992; it was a comprehensive and relatively coherent document. But Parliament then designated the State Property Fund as the agency responsible for developing the program. Istitutional Aspects 8. An important step was taken in the fall of 1991 with the creation of the Ministry of Destatization and Damonopolization, the State Property Fund, and the Committee for Entrepreneurship. All three bodies reported at that time to the State Minister of Property and Entrepreneurship who was a cabinet member. 9. At the beginning of December 1991, the Ministry of Destatization and Demonopolization developed a draft of the Law on Privatization based largely on a case-by-case approach to privatization, with some discounts for employees, and a separate, easier, privatiztion path for small-scale enterprises. This draft law was not approved by the Cabinet of Ministers. The State Minister of Property and Entrepreneurship appointed his own group, which worked on the development of a fast "voucher give- away" scheme. This small group developed three draft laws on privatization, which were sent to Parliament. The power and responsibility for preparation and execution of the privatization program was then given by Parliament to the State Property Fund, despite the fact that the Ministry of Destatization and Demonopolization was mentioned in the Law as the body to prepare and develop the State Privatization Program. 10. Following intense parliamentary debate, the government proposal was substantially changed. First, Parliamnent handed even more power to the State Property Fund by naming it the owner of about 17,000 enterprises and prohibiting delegation of Its authority to any branch ministries. Second, Parliament subordinated the State Property Fund to itself. This created much confusion, as those among the Cabinet of Ministers with branch ministry portfolios, who "owned" enterprises, saw "their" enterprises transferred to the State Property Fund. Since then, the structures for privatization have been simplified as the State Property Fund has been given full responsibility for privatizing republican property. 11. At the same time, in March 1992, the President changed the structure of the Government, reducing the number of ministries and liquidating the intermediary level of State Ministers, appointing a single individual as deputy Prime Minister and Minister of Economy to head the former Gosplan. Principal Issues and Recommendations 12. Spontaneous Privatization. There are about 8,000 leased enterprises and another 68 corporatized enterprises. According to the State Privatization Program, the Government will introduce quick and obligatory privatization procedures for these leased enterprifes. Despite a lack of detailed  -3- information, it Is clear that spontaneous privatization is continuing despite Decree 506. Most companies involved are small and mid-sized. However, one of the well-known examples of spontaneous privatization is a large enterprise, a TV assembly company in Lvov, which is said to have been privatized without any legal basis. 13. There Is a need to capitalize on the dynamics of spontaneous privatization and harness it as a driving force in the transformation to a market economy. Research needs to be carried out and an assessment made on the extent to which spontaneous privatization might be accommodated within existing Ukrainlan laws. The more legitimate forms of spontaneous prlvatization might be helped by proper legislation. Researcu should also be developed on existing examples of spontaneous privatization as pilot cases. The results should be integrated into the design process for the legislative framework. 14. Legitimate cases of spontaneous privatization might also be treated as models for enterprise managers and workers groups who could visit them. If left alone, there is a rlsk that the process might cause the proliferation of undesired and inefficient privatization methods around the country, as experience in Hungary and Poland has shown. 15. Another Important reason for research on spontaneous privatization is qonnected with development of a "bottom-up" approach which Is the approach most likely to succeed. With a little correction and with the right legal or other technical assistance, locally developed spontaneous privatizations might provide a relatively easy way to quick privatization of mid-sized contpanies. 16. General Legal Issues. In addition to shortcomings already mentioned, the law overregulates the privatization process, defining in detail many areas, while at the same time leaving others without guidelines. The State Privatization Program tries to take corrective action and has been quite successful in some areas. However, the law should be amended to simplify the legal framework and allow for more flexibility. 17. Small-Scale Privatization. Small-scale privatization applies mainly to the food and consumer goods retail trade, consumer services, housing, etc. It is defined by the law as the privatization of objects, which possess a book value of assets not exceeding Rb (coupons) 20 million. According to law, these objects are to be sold by the State Property Fund, Its local branches or local privatization bodies, to buyers (who cannot be either legal entities with any portion of state ownership or government bodies) by auction or public bidding. The starting price at the auctions is to be based on the adjusted book value of fixed and current assets and inventories, including accounts payable and receivable. 18. Experience In other countries has shown that small-scale privatization can and should move rapidly, and can provide a "Jump start" to the privatization process. In Ukraine, the process of small-scale privatization has been delayed by a provision in the law giving employees and citizens the right to use vouchers and non-cash accounts as a mean of payments for assets to be privatized. This voucher scheme will take at least a year to develop. Similarly, the provision that small-scale privatization should await the introduction of the hyrvna is also likely to cause delays. Another time-consuming factor is the intention to sell small businesses as going concems with complex valuation and approval procedures to be completed in each case. The fastest and most successful mahod of small-scale privatization is by auction of assets, with in some cases leasing of the buildings. The legal framework shoulld be modified to correct these problems.  -4- 19. A Small-Scale Privatization Pllot Program should be prepared with the ivtention of developing detailed models for the privatization of different types of enterprises. Furthermore, to speed up the process, "do-it-yourself" manuals should be prepared for use by local municipalities. 20. The Law states that the objects of small-scale privatization may be purchased with personal funds, borrowed funds, or in exchange for privatization certificates which are to be introduced soon. These objects can also be privatized in exchange for 'non-cash accounts" prepared by the Savings Bank. Some of the objects of small-scale privatization can also be purchased for freely convertible currency. The rate of exchange for such a purchase will be fixed by the National Bank of Ukraine (NBU). Preferential rates will be applied to foreign investors. 21. Mass Privatization/Voucher Scheme. The designation of both the NBU and the Savings Bank as responsible for issuing and distributing vouchers, if implemented, will cause confusion due to overlapping responsibilities. Moreover, as the NBU reports directly to the Parliament, the Government would have no control over this process. Without changing this insth.tional arrangement, the voucher scheme might not start. 22. A decision has been taken by Parliament that rapid and free of distribution of state property to the population will be the most appropriate method for quick privatization. Vouchers and non-cash accounts are to be the principal means of payment for privatized property. The NBU will be responsible for issuing vouchers. However, the NBU has only just started to develop a basic understanding of the difficulties of preparing a voucher scheme and the logistical problems in implementing it. The Savings Bank, responsible for non-cash accounts, is also in the early stages of understanding the complexity of this process. Neither agency is close to developing an implementation program. 23. Privatization laws and the State Privatization Program are tying the moment of valuation of the state property to the date of issuance of vouchers. Since a legal basis for valuation has not been determined, this will certainly cause delays even in starting up pilot projects. A pilot privatization program should begin as soon as possible, and the lessons of experience fed back into the design of the legal and regulatory framework. 24. Management/Employee Buy-Outs. Existing legislation provides workers and management with the possibility of buying at a discount all or part of the company. Yet, in order to participate, employees must form a buyers' association which shall include within its membership not less than 50 percent of the workers. When privatization is by auction or public bidding and there is more than one potential buyer, the buyers' association is treated equally as any other applicant. However, it has the right to use vouchers and non-cash accounts to bid. In addition, the April 1992 law on the Leasing of State Enterprises allows leasing by workers' collectives with an option to buy at the end of the lease period, effectively blocking other forms of privatization. 25. Buyers' Associations. There are many uncertainties surrounding the so-called buyers' associations. There is inadequate information on how these newly created, semi-legal entities ill work in practice. How to set up their boards, what will be their election mechanisms, how ownership rights will be distributed among participants, how banks, courts and other institutions will deal with them, and how to transform these associations into recognized legal entities have yet to be determined. There is a risk that, once established, their uncertain status will cause further delays in privatization. It would be  advisable to follow well known and successfully operating models or, if needed, design new ones with the participation of Ukrainian and foreign lawyers with appropriate experience. 26. Antimonopoly Committee. Given the high concentration in some industrial subsectors, it will be important to strengthen the recently created antimonopoly committee which has authority to break up monopolistic structures, and to enforce antimonopoly rules. 27. Foreign Investment Promotion Agency. A foreign investment promotion agency should be created in order to encourage the inflow of foreign capital. The agency should cooperate with the privatization agency in all cases where foreign investor participation is expected or desired. 28. Financial/Accounting Issues. Basic accounting standards following internationally accepted norms should be established to cover requirements such as opening and closing balance sheets, profit and loss accounts, etc. Standard methods of valuation should be developed such as book value, adjusted book value, discounted cash flow, replacement cost, etc. Disclosure standards should also be drawn up for incorporation in information memoranda, simplified prospectuses, etc. 29. Purchase terms for assets and shares need to be formulated together with tax incentives for buyers and privatized companies. A legal framework for leasing, with standard agreements, as well as financial support for leasing contracts should be developed. New sources of capital should be found. Support from financial institutions such as foreign banks or investment funds should be sought since it can play an important role ij speeding up and strengthening the privatization process. Technical Assistance Needs 30. Technical assistance is urgently needed in the following areas: - general privatization strategy; - amendments to laws; - completion of the State Privatization Program; - development of methodologies, guidelines, regulations, standard documentation, and operating manuals for all aspects of privatization; - definition of the institutional structures, systems and other requirements; - design and implementation of training programs.  -6- ATrACHMENT Resource Requirements The privatization process In Ukraine has virtually no resources at its disposal. Based on the experience of Poland, Czechoslovakia and Hungary, there should be approximately 500 people - 300 In Kiev and 200 at the local level - working exclusively on privatization. To this end, a study to determine the organizational requirements in terms of structure, internal division of labor, lines of reporting, job descriptions, compensation system, etc., should be undertaken.' In preparation for the study, a budget for both local and foreign exchange requirements should be prepared and office space in Kiev and at the oblast level identified. The design of an information system to support the enterprise selection and privatization process should be included In the privatization action plan. This would require the acquisition of computer hardware and software for gathering and processing the necessary information on companies, investors, resources, etc. (the database). Training at various levels should start immediately after selection of staff. The design of training courses for government, local authority and enterprise personnel, as well as the design of a privatization marketing and public relations campaign should be the subject of separate professional advice. I/ Such a study should take between two and three months.  ANNEX B PRIVATE SECIOR DEVELOPMENT 1. The following sections, based on enterprise intervlews and the results of a survey conducted in Ukraine in April 1992, present a discussion of the emergence of prlvate enterprise, types of enterprises, obstacles to enterprise growth, and an aWalysis of the legal and regulatory environments and their effect on private enterprise. Other relevant issues are presented In conjunction with recommendations for development of a competitlve environment during the transition period. The Private Sector in Early 1992 2. As in the rest of the former Soviet Union, private enterprises are a relatively new phenomenon in Ukraine. However, they are emerging at a rapid pace, and by early 1992, near'y 43,000 had been registered. Tax records show that almost 20,000 enterprises were in full operation before the end of 1991. These enterprises are spread throughout the country, ranging in number from 140 in Ternspolskaya region to 2,800 in Kiev region. An average 750 enterprises are active in each of the 26 regions of Ukraine - their number exceeding 1,000 In Dnepropetrovskaya (excluding Kiev), Donetzkaya, Krimskaya, Kharkovskaya and Odesskaya. Total employment by private enterprises is estimated at around one million. 3. A survey of randomly selected private enterprises', conducted in April of 1992, confirmed anecdotal evidence on the status of private enterprises and provided a systematic ranking of the constraints that entrepreneurs consider to be the greatest obstacles for business development. This section is based on the results of the survey as well as on a series of complementary interviews conducted through Central and Eastern Ukraine. 4. While many private enterprises are less than a year old, entrepreneurs leading them are not uniformly young - more than half of them have had substantial careers in state enterprises. Most of the older enterprises began as cooperatives under the 1988 Union law which partially opened the door for private, legal business activity. The overwhelming majority of entrepreneurs are university educated, and the sectoral distribution of enterprises reflect this fact in that engineering, software and consulting services account for over 40 percent of the enterprises with an identifiable area of concen:ration.2 5. Trading is the main activity of less than one-fifth of all enterprises. Enterprises producing industrial goods and consumer items represent, respectively, 24 percent and 22 percent of those surveyed, and with an identifiable core activity. The majority of enterprises engage in trading (unrelated to their other areas of activity), taking advantage of the gross arbitrage opportunities which have played a crucial role in the recent process of capital accumulation in private hands. The trend in private business is A set of enterprises to be surveyed was selected at random from city registers in 9 different urban areas. The actual 223 enterprises interviewed were a smaller subset excluding a significant proporion that could not be located. 2 A feature of the youngest enterprises is their 'indecision'. Because of the rapidly changing environment and difficulties in becoming physically settled, many enterprises are probing into different areas of activity. Thus, nearly 40 percexnt of the survey sample was unclassifiable in terms of a core activity.  -8- encouraging in that many ertrepreneurs are parlaying the capital and market knowledge acquired through trading operations into manufacturing investments. 6. Contrary to what appears to have been the case wlth cooperatives (which were mainly construction concerns, service providers, or subcontractors for large 'host" public enterprises), a very significant proportion of private ente prises is engaged in manufacturing and is more likel; to subcontract out speclflc tasks to state enterprises than to do subcontracting for them. The enteiprises surveyed, for instance, subcontracted out 14 percent of their production, while subcontracting for others accounted for only 9 percent of output. 7. 'Te overwhelming majority of enterprises are owned by a small number of individuals. Although state enterprises appear to have often played a "sponsorship" role for a significant segment of the private sector, state shareholding in private enterprises is almost negligible on average. Many enterprises nevertheless depend to a large extent on a major state enterprise customer (more than 40 percent of sales, on average, are made to one state enterprise) - even though only a small part of this dependence appears to be explained by subcontracting relationships. 8. Less than one-third of private enterprises have outstanding bank loans, although the overwhelming majority of their financial transactions take place through the banking system (over 80 percent of all earnings are in the form of "bank transfers"). Among enterprises currendy without bank credit, nearly threequarters of the enterprises without bank loans reported not having applied for one - leaving a litle more than a quarter reporting their applications rejected. This is consistent with other indications that the cost of bank financing is more of a deterrent than the lack of access - although access appears to be determined by unconventional patterns3. Indicative also of the peculiarities of the current banking system is that it tends to be the younger enterprises that have greater access to credit. 9. Contributing to an atmosphere of regulatory uncertainty - and acting as an impediment to relative price adjustments - is the continued existence of profitability ceilings which average about 27 percent. Thus, even though price controls are generally not considered a problem any longer, enterprises still find it necessary to take profitability ceilings into account in their pricing (and costing decisions). Concern with regulatory matters, more generally, is foremost in the minds of private entrepreneurs at this point (see perceptions of obstacles to growth btlow). These range from legal ambiguity to oppressive taxation. Entrepreneurs consider them as even more serious obstacles than inadequate premises and input supply disruptions (which the survey confirmed are nonetheless significant problems). The Legal/Regulatory Environment 10. As in the rest of the former Soviet Union, legal activity by private entterkrises became possible in Ukraine just a few years ago. A 1988 law enabled the establishment of private businesses with limitations mainly on the employment of hired workers. Therefore, a first generation of private 3 New banks are often not independent financial intermediaries, but "credit clubs" which serve mainly a closed circle of businesses. They may offer preferred lending terms to enterprises in their networks and higher terms to other enterprises. This is probably also the explanation for the wide range of interest Mtes that enterprises reportedly pay.  -9- enterprises emerged under the disguise of "cooperal ves" *- the only legal form a prlvately owned enterprise could adopt -- and quickly thousands of cooperatives were operating in Ukrainm. 11. In August 1990, again on the basis of a USSR law, it became possible to establish private enterprises outright and they began to proliferate - even though many business practices which would be proper in market economies were still crlminal under Soviet law. Ukrainian laws on "Entrepreneurial Activity" and "Enterprises" became effective, respectively, on March 1 and April 1, 1991. Additlonal legislation has addressed, among others, the issues of consumer rights protection, commodity exchanges, trade in securities and financial instruments, and business associations. These legislative acts are well within the civil law tradition common to most of the industrially developed world, but fall short of providing an adequate business environment. 12. The deliberate aims of this body of legislation are allowing most typical market transactions to take place without legal impediments, and are creating a specifically Ukrainian legal- economic space. By January 1, 1992 all enterprises based in Ukraine were required to have registered according to the new laws (and, by all accounts, they complied). These laws are very clear in recognizing private property rights and the validity of the profit motive. Senslbly, they rely on the "negative list" approach to regulate enterprise activity. For instance, only a specified short list of activities requires a special license and only a specified list of categories of individuals (e.g., military personnel) is barred from entrepreneurial activity. 13. Nevertheless, the laws are lite more than basic principles, and nearly a year after their enactment, altnost no progress has been achieved towards implementation of some of their key elementq or towards ensuring consistency between legal principles and bureaucratic administration. - Item: the law prohibits unwarranted interference in economic and other activity on the part of the state and recognizes the right of entrepreneurs to be reimbursed for losses suffered as a consequence of instructions or improper performance by state agencies and officials. The courts and state arbitration commissions charged with this entrepreneurial defense, though, are neither equipped nor inclined to play such a role. - Item: the law commits the State to guaranteeing all entrepreneur. equal opportunities for access to technical, financial, information and natural resources; even more speciflcally, the State is to "furnish plots of land and transfer state property necessary for performance of economic activity". Yet, it is precisely the lack of access to land, equipment and raw materials controlled by the state that is one of the main obstacles to development of private enterprise. 14. In addition, the new laws incorporate contradictions rooted in past practice which are not consistent with private enterprise and free markets. For instance, the law appears to make all enterprises subject to compulsory "state orders". Similarly, the law stipulates that "the entrepreneur or individual hired by the entrepreneur may be recruited to perform state duties during working hours". Finally, the law imposes rather open-ended social burdens on the enterprises and appears to give employees wide powers to influence labor practices and compensation (it appears to apply the paradoxical principle of self- management of the workforce to privately owned enterprises). 15. The legal enterprise form options in Ukraine are similar to those in most Western countries. In practice, it makes sense to think about two basic types of enterprises: "joint stock' companies and "small" businesses -- though these are not strictly mutually exclusive legal categories (see  - 10- Chant 1. Small enterprises4 include both unlimited and limited liability enterprises, and there are very close linkages betweeni ownership and management. Almost all of the genuinely new enterprises in Ukraine fall in this category. Also, many cooperatives have transformed themselves into small businesses, a considerable proportion of these having emerged out of state enterprises. 16. Joint stock companies have generally resulted from the pooling of assets In the hands of state enterprises, government agencies (principally local authorities), and private entrepreneurs. Thers are relatively few joint stock companies in Ukraine at present but their numbers are growing rapidly as small enterprises 'graduate" and seek strategic alliances and/or capital; and as more avenues for quasi- privatizing state enterprise assets become available. There is also a growing number of quasi-private "leased" enterprises which have emerged under a particularly vague legal umbrella. Many of these are medium-to-large in size, and information on them is scant. Th, consist either of parts or the whole of state-owned industrial enterprises, and their evolution is an ii. - ant part of the ongoing process of "spontaneous" privatization. Entrepreneurs' Perceptions of Obstacles to Growth 17. The two most striking conclusions from the April 1992 survey are the importance that entrepreneurs attach to taxation and regulation as impediments to their businesses and the unanimity in their views - across sectors and regions. The high level of taxes and regulatory instability were singled out as the most serious obstacles to the growth of 95 percent and 90 percent, respectively, of the enterprises surveyed. Price instability and political uncertainty were also identified as of great concern. These obstacles tower in terms of their perceived seriousness (see Chart 2) over other clearly important obstacles - such as input supplies and availability of premises. 18. Also remarkable is the entrepreneurs' unanimity in their ranking of obstacles to growth. All types of enterprises, regardless of size and of sector, consider taxes and regulatory instability as the main constraints facing them. Similarly, all types of enterprises see access to credit and labor-related issues as relatively minor problems at this stage. The few noteworthy differences have to do with enterprise size: larger enterprises have more problems with accounts receivable; the high cost of finance is a greater deterrent for smaller enterprises; and larger enterprises find it harder to recruit competent workers. Differences across sectors - beyond the obvious5 - are not apparent. 19. Second in importance to obstacles related to the direct role of the state (taxes, regulation) and to the transition process (price instability, political uncertainty) are obstacles concerning premises and inputs as well as monetary and finance-related ones (see Table 1). The larger enterprises are more seriously affected by access to resources (inputs, equipment, premises), while the sma!ler eiit;rprises give relatively more importance to their cost. 4 Businesses that in Ukraine are called 'small' correspond to the small and medium size enterprises (SMEs) category used in most other countries. The formal definition of small business is based on the workforce thresholds (e.g., 200 people in industry and 15 in commerce) which were used in the former Soviet Union. F Por instance, input supply is seen as a more serious problem by manufacturing enterprises and transport constraints are more troublesome for enterprises involved in trading.  Chart 1 IUKRAIN: TYPES OF PRIVATE ENTERPRISEI SOLE PARTNERSHIP LPMiED JOINT STOCK PROPRIETORSHIP LYABILITY COMPANY COMIPANY SMALL Average 19 employees; Average 27 employees and Many partnerships Almost none are small BUSINESS one-quarter of all private accounit for almost 30% of evolved into this type, businesses. enterprises and an even enterprises. They have which accounts for over greater proportion of strong roots in the state one-third of all enterprises enterprises created in last enterprise system and and employs an average year. highly educated partners. of 23 people. O1MER Virtually all are smal Only a few are not small Joint ventures (often with The largtst (averaging businesses. businesses. state participation) close to 200 employees), generally belong to this they tend to be well- type. They are few and connected to the banking tend to be small in size. system and rooted in state enteprises. 20. Although surprisingly they are considered relatively unimportant, obstacles to access to finance and transport constraints are of some zoncern. However, neither inputs nor outputs were considered serious problems for transport. Finally, demand weaknesses, price controls and labor relations are not considered to be significant obstacles at this point. Reform Agenda for Private Sector Growth 21. Entry and Other Aspects of a Competitive Environment. A competitive business environment is crucial for efficient economic growth. In Ukraine's present situation, the key for stimulating competition is to facilitate entry by new enterpris"s in virtually all sectors and to eliminate existing monopolies whenever possible - utilizing, in particular, the opportunities that the privatization process will offer. Anti-trust and similar policies to protect competition are unlikely to be as effective in preventing monopoly power abuses in tradable goods as liberalized imports and a convertible currency. 22. Simplifying regulations and eliminating legal obstacles to private business activity are prerequisites for new enterprise formation in a wide range of sectors. As the survey suggests, they are also key to the growth potential of existing enterprises. The objective should be to put in place transparent, expedient business registration and regulation mechanisms which facilitate entry, promote competition and otherwise defend the public interest - with minimal government intervention. Jurisdictional issues also need to be clarified to minimize the regulatory and administrative burden that overlapping authorities impose.  Chart 2. - 12 - CA~~~~~~~~~~~~~~~~~~~~C C. = Importance of Obstacle c Labor regulations 'A 0 Scarcity of competent workers 0 * m Lack access to finance _........ High cost of finance 0 . Lack access o equipmenS_ : _, .' .=. . - ................. . .... .. . . .. ....... O.... Lack acces-s to equipment. C q m > Payment arrears of customers .m m Z _ ' ~~~~~~~~~H Lack of production premises...1 m Cost of space/premises _ . , m Unreliable delivery of inputs G) Regulatory Instability ._... .~~~~~~~... .... ...... High level of taxes . . .......-. ............... ...- '.'" ' '...  -13- Table 1: UKRAINE: PRIVATE ENEERPRISES BY SIZE Ranking of obstacles for business: (1-no obstacle; 5=most serious obstacle) Lack of office space 2.4 2.3 2.4 Lack of production premises 3.5 3.3 3.4 Cost of space/premises 3.1 3.3 3.3 Not enough customers 1.9 1.9 1.9 Lack of access to finance 2.0 2.2 2.2 High cost of finance 3.1 3.5 3.4 Payment arrears of customers 3.2 2.4 2.6 Lack of skilled technicians 2.2 1.7 1.8 Scarcity of competent workers 2.3 1.7 1.8 Labor regulations 1.8 2.0 1.9 High level of taxes 4.6 4.7 4.7 Bureaucratic procedures 3.8 4.0 4.0 Unreliable delivery of inputs 3.6 3.2 3.3 Lack of access to equipment 3.1 2.8 2.9 Political uncertainty 3.9 3.6 3.7 Price controls on output 1.8 1.8 1.8 Inflation/price instability 3.9 4.0 4.0 Monetary uncertainty (currency) 3.4 3.1 3.2 Regulatory instability 4.6 4.5 4.5 Output transport constraints 2.4 2.2 2.3 Input transport constmints 2.5 2.3 2.3 Monthly sales (rubles, thousands) 2863.6 2179.6 2341.6 % of saloes to largest S customer 44.9 40.4 41 % of sales to largest private customer 20 24.6 24 % Enterprises with investment loans 30 10 18 % Enterprises with working capital loans 50 30 48 Average age of enterprise (years) 1.7 1.3 1.4 % of Entrepreneurs with university degree 85 91 90 Number of enterprises in sample 46 168 223  - 14 - 23. Completing the process of "legalization" of business activities and adopting simple, automatic licensing or registration procedures - to facilitate entry and encourage transparency - should be urgent priorities. For Instance, legal constraints and regulatory ambiguities on private trade could be eliminated and replaced by a simple, automatic registration system. Efforts to eliminate unnecessary requirements and streamline other procedures (such as separate registration with multiple public agencies, or rules complicating the process to obtain a stamp or open a bank account) should also be pursued comprehensively. The requirement for multiple registration (not specified in the law but nevertheless in effect) with internal affairs, statistlcs, labor, and other government agencies is one such obstacle which should be eliminated. Some of these obstacles have roots in the system of district-level registration (unfortunately, specified in the law), which is both insufficient to meet all regulatory requirements and creates the opportunity for inconsistent and arbitrary administrative behavior across localities. Consideration should be given to changing the locus of registration or, at least, to making local authorities simply the administrators of an integrated system of registration with centralized records and simultaneous logging of registration with all the relevant authorities. 24. The importance of freeing entry into most areas of economic activity cannot be overemphasized. Achieving free entry requires, under the present circumstances, more than the elinination of regulatory and legal barriers. Land policy plays a key role in enabling the creation of new enterprises; it Is critical that land and buildings be made available for new enterprises to obtain requisite office and production space. Until recently, it had been the dubious legality of most business undertakings that provided a strong bias for 'foot-loose' activities. Now it is the lack of availability of land that prevents the bias from diminishing quicldy. Both office space and productive premises are Important constraints to entry and expansion. Realistically, widespread transfers of property with proper documentation will not be feasible for a number of years. An alternative would be to facilitate leasing by developing a transparent, standard approach. Ihe leases (5-15 years depending on the type of property) should be long enough to encourage investment, but not so long as to preempt a definitive land policy reform in the future. It is crucial that the leases be transferable - so that they have some collateral value and so that no unnecessary rigidities are introduced in the system. 25. Even for enterpris as (generally using state-owned assets) which have adequate premises, uncertainty about the terms and seutirity of leasing agreements is a major obstacle to resource mobilization for business expansion. Encouragement of long-term leasing and other measures designed to allow a sturdy commercial real estate market to develop should therefore receive immediate priority. In this context, it is also crucial that as many government-owned buildings as possible be placed on the market (e.g., buildings formerly occupied by the Communist Party and housing government agencies with functions unnecessary in a market economy). The inertia in letting government entities expand to fill the available space should be checked, and whole buildings should be identified and freed up for private use. Similarly, state enterprises with assets mainly consisting of real estate (such as trading companies) should be liquidated, rather than privatized - to get the government to benefit from real estate sales and, most importantly, to ensure that the privatized enterprises do not have the enormous advantage over potential competitors of being the only ones with premises. 26. The legal framework for private enterprises, as indicated above, is essentially sound. However, implementation measures and administrative practice still include unnecessary obstacles for private business activity. Exit regulations (such as bankruptcy procedures) are among those conspicuous by their absence and should also receive attention. More generally, fair and expedient mechanisms for dispute resolution, contractual enforcement and administrative appeal (also lacking, as indicated above) are very important incentives for private investment, and should be developed urgently.  - 15 - 27. State Enterprise Restructuring and Private Business. Virtually all private enterprises have some connection with state enterprises. Garment manufacturers buy their materials from state enterprises and often use state stores as sales outlets. Both light and heavy industry obtain their equipment from state enterprises. Engineering companies recruit their highly skilled personnel from them, and many companies are formally organized as a string of partnerships in order to coopt the state enterprises supplying raw materials, premises and equipment. Relationships of private businesses subcontract with state enterprises and vice versa, although on average, this does not account for a large proportion of output. 28. Although subcontracting appears to be declining in importance, private businesses often depend greatly on state enterprises as customers. The average private business sold over 40 percent of its output to a single state enterprise. For bus;-esses involved in industrial production and engineering, the proportion is almost 50 percent. These types of businesses also received the highest proportion of their earnings (over 90 percent) through bank transfers, which for other private enterprises represent less than 80 percent of earniings. Privatization priorities include retail trade and other services. This is certainly an area in which development of private ownership should be sought immediately, and it is crucial that early privatization include transport fleets. At the same time, the sectors under privatization should be opened up for additional entry (e.g., ensuring liberal licensing of trade and transport activVies, and releasing not only enterprises but also individual assets, such as premises and trucks, into the market). 29. While equally urgent, large-scale privatization will unavoidably be a lengthier process. Every effort should be made to get all kinds of privatization going on a massive scale. It is also critical to move rapidly to change management incentives in enterprises which will not be privatized - whether because of political decisions or because of lack of investor interest, so that they become commercial operators in a competitive environment (enforced, inasmuch as possible, with the help of liberalized imports). Immediate commercialization of state enterprise operations and imposition of hard budget constraints to force them to shed excess assets and streamline operations will be critical for the development of private business. 30. Privatization strategies and the issues connected with their implementation are addressed elsewhere in the report (Annex A). It is worth noting here three points of importance for broader private sector development efforts: (a) The process of privatization will present many opportunities for stimulating competition. In particular, the segmentation of existing enterprises prior to or during privatization will ensure that the new, smaller enterprises compete among themselves and with other such disintegrated enterprises. Clearly, there is a trade-off between the urgency of privatization and the importance of segmentation. Expedient and pragmatic means will have to be used to avoid creating bottlenecks in the privatization process. 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